What Is a Non-Compete Agreement? Its Purpose and Requirements

Non-Compete Agreement

Investopedia / Jake Shi

What Is a Non-Compete Agreement?

A non-compete agreement is a legal agreement or clause in a contract specifying that an employee must not enter into competition with an employer after the employment period is over. These agreements also prohibit the employee from revealing proprietary information or secrets to any other parties during or after employment.

Many contracts specify a certain length of time when the employee is barred from working for a competitor after they end employment. Employers may require employees to sign non-compete agreements to keep their place in the market. Those required to sign these agreements may include employees, contractors, and consultants.

Key Takeaways

  • A non-compete agreement legally binds a current or former employee from competing with an employer for a specific time after employment ceases.
  • Under such an agreement, the employee must not reveal any trade secrets learned during employment.
  • These contracts outline how long the employee must refrain from working with a competitor, in a geographic location, or in a specific market.
  • Some states, like California, refuse to enforce non-compete agreements.
  • Non-compete agreements can prevent workers from getting a job in their field if they leave a position.

The validity and enforcement of a non-compete vary by jurisdiction and may require the former employer to keep paying the ex-employee a base salary during the non-compete period.

On Jan. 5, 2023, the Federal Trade Commission (FTC) proposed a ban on noncompete clauses, saying that eliminating curbs that affect one in five American workers will increase wages by nearly $300 billion a year. The rule would apply to employees and independent contractors, paid and unpaid. It would require employers "to rescind existing noncompetes and actively inform workers that they are no longer in effect." The public can submit comments through March 10, 2023.

Understanding Non-Compete Agreements

Non-compete agreements are signed when the relationship between employer and employee begins. They give the employer control over specific actions of the employee—even after that relationship ends.

These agreements have specific clauses stating that the employee will not work for a competitor after their employment is over, regardless of whether they are terminated or resign. Sometimes, employees are prevented from working for a competitor even if the new job wouldn't involve disclosing trade secrets.

Some contract terms may include the length of time the employee is bound to the non-compete agreement, the geographic location the employee may work in post-employment, or the market they may work in. These agreements may also be called a "covenant not to compete" or a "restrictive covenant."

Non-competes ensure the employee will not use information learned during employment to start a business and compete with the employer once work is over. It also ensures the employer keeps its place in the market.

Non-competes should be designed to protect the best interests of the employer and the employee.

Components of a Non-Compete Agreement

Non-compete agreements are generally not standardized, but many have similar restrictive elements. Some of the components you might see in a non-compete agreement are:

  • Duration: Non-compete agreements cover specific time frames, such as six months or one year. Long-term agreements are prohibitively restrictive for employees because they can keep them from finding work after leaving an employer.
  • Geography: Some agreements consider geographical location, prohibiting an ex-employee from working in specific areas for a set time.
  • Scope: Non-compete agreements must specify the type of work or services that an ex-employee cannot provide. They should include information, techniques, procedures, and practices that are unique to the business or otherwise proprietary.
  • Competitors: The competition must be defined in the agreement. The company doesn't need to list them all, but it should give a general idea of the industry and types of businesses the employee agrees to not work in.
  • Damages: Employers define the damages they are entitled to if an employee breaches the agreement.

When and Why Are Non-Compete Agreements Used?

Businesses use non-compete agreements to protect their intellectual property, trade secrets, proprietary information, procedures used to produce their goods and services, or to maintain their competitive advantage.

If a contract were not in place regarding the disbursement of information to competitors, many businesses would lose their advantage. Ex-employees could legally use the information they obtained at one company to help a new employer gain an advantage. Additionally, an ex-employee might be able to start their own business using information acquired from another firm.

If this information is provided to competitors, a company might be forced out of the market and industry—this makes non-competes an essential part of the hiring process for many enterprises.

Industries That Use Non-Compete Agreements

Non-compete agreements are common in the media. For example, a television station might have legitimate concerns that a popular meteorologist may siphon viewers away if they began working for a rival station in the same area. This would be considered a reasonable cause to sign a non-compete agreement in most jurisdictions. Other industries where these agreements are typically found include:

  • Financial services
  • Corporate management
  • Manufacturing
  • Information technology

Non-compete agreements are enforced differently in many states. Therefore, it's best to consult an employment lawyer to find out about non-competes in your state.

Legalities of Non-Compete Agreements

In the U.S., the legal status of non-compete agreements is a matter of state jurisdiction. States vary widely in their enforcement and recognition of non-compete agreements, and many state legislatures have updated legislation related to non-compete agreements.

Non-compete agreements cannot be enforced in North Dakota and Oklahoma. California does not recognize non-compete agreements, and an employer who binds an employee to one after employment is over can be sued. Hawaii banned non-competes for high-tech companies in 2015. In 2016, Utah changed legislation, limiting new non-compete agreements to only a year.

Most states adopt some sort of standard that a non-compete agreement must not be egregious in the length of time or geographic scope and shouldn't meaningfully restrict a worker's ability to find employment. However, jurisdictions differ widely in interpreting what terms of a non-compete agreement would be overly demanding.

Non-Compete vs. Non-Disclosure Agreements

Non-compete agreements are distinct from non-disclosure agreements (NDAs), which generally don't prevent an employee from working for a competitor.

Instead, NDAs prevent the employee from revealing information the employer considers proprietary or confidential, such as client lists, underlying technology, or information about products in development. 

Pros and Cons of Non-Compete Agreements

  • Protect trade secrets and proprietary information

  • May inspire more innovations from employees who sign them

  • Match employers with employees looking for long term positions

  • Reduce employee turnover

  • Weaken the bargaining power of employees

  • Significant amount of wait time before applying for another job in the same field

  • Few social benefits

  • Can restrict employees without trade secrets

Pros Explained

  • Protect trade secrets: These agreements can protect employers from employees leaving for a competitor and sharing proprietary information. That being stated, the agreements should be fair to both the employee signing the agreement and the employer who is issuing it.
  • Inspire more innovations: Non-compete agreements can keep ideas and information from spreading, encouraging competitors to innovate to keep up with other businesses.
  • Used for employee matchmaking: A non-compete agreement may be used to match employers with employees who plan on staying put in a job or prize being trusted with valuable information.
  • Reduce worker turnover or exit: Non-competes can reduce employee turnover because they tend to restrict other employment options. Additionally, businesses with non-competes may need to provide training and education for their employees to continue innovating, benefiting their careers and market value.

Cons Explained

  • Weaken employee bargaining power: Workers are prohibited from seeking a better paying position or bargaining for more pay or benefits when under a non-compete.
  • Wait time for a new job can be significant: Non-compete wait periods may keep employees who decide to leave from finding meaningful employment in their fields of expertise. Employees who sign non-compete agreements may leave their industry entirely if it is too hard to find a new job after signing one.
  • Few social benefits: Non-competes generally only benefit the company, not providing much in the way of social benefits for employees.
  • Can restrict employees without trade secrets: The U.S. Department of the Treasury's Office of Economic Policy reported that less than half of workers under non-compete agreements have trade secrets. Unfortunately, this means that more than half of workers under non-compete agreements are unnecessarily restricted by these clauses, further hampering their ability to bargain.

How Long Do Most Non-Competes Last?

Typical non-compete periods are six months to one year, but they can last longer. However, it is difficult for businesses to enforce long-term non-compete agreements legally. Some states will not enforce these agreements, and a few do not recognize them as legal.

How Do I Get Around a Non-Compete Agreement?

If you've signed a non-compete and break the agreement, you could, in theory, be sued. State laws (which differ) set the enforceability (or not) of non-compete agreements.

Are Non-Competes Really Enforceable?

State laws differ on the legality and enforceability of non-competes. The law firm Beck Reed Riden LLP has surveyed states and compiled a list of their stances on non-compete agreements, protected interests, standards, and exemptions.

The Bottom Line

Signing a non-compete agreement may not always be in your best interest, but it's usually in the best interest of your potential employer. It helps to talk to an employment attorney before you sign one for clarification on your state's laws and consider the possibility that you may have difficulty finding work in your field if you leave your position.

Not all states uphold non-compete agreements, but some do, making it worthwhile to know ahead of time how a non-compete agreement might play out if you leave your job or break your agreement.

Article Sources
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  1. Federal Trade Commission. "FTC Proposes Rule to Ban Noncompete Clauses, Which Hurt Workers and Harm Competition."

  2. Regulations.gov. "Non-compete Clause Rule (NPRM)."

  3. State of North Dakota Courts. "Osborne vs. Brown and Saenger, Inc."

  4. Justia U.S. Law. "15 OK Stat §15-219A. Noncompetition Agreements."

  5. State of California Department of Justice. "Attorney General Bonta Reminds Employers and Workers That Noncompete Agreements Are Not Enforceable Under California Law."

  6. Hawaii State Legislature. "H.B. No. 1090."

  7. Utah State Legislature. "Utah Code Section 34-51-201."

  8. U..S. Chamber of Commerce. "6 Questions About the Impact of Noncompete Agreements on Businesses and Employees."

  9. U.S. Department of the Treasury | Office of Economic Policy. "Non-compete Contracts: Economic Effects and Policy Implications."

  10. Beck Reed Riden, LLP. "Employee Noncompetes | A State-by-State Survey."

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